Docstoc

gas and electric utilities

Document Sample
gas and electric utilities Powered By Docstoc
					                                           2007




NARUC  
        Decoupling For Electric & Gas 

                                     Utilities: 

                 Frequently Asked Questions 

                                        (FAQ)





                     Grants & Research Department
                                  September 2007




The National      1101 Vermont Ave., N.W., Suite 200
                           Washington, D.C. 20005
Association                  Phone: 202-898-2200
of Regulatory                   Fax: 202-898-2213
Utility                      Http://www.naruc.org
Commissioners
Introduction
State Public Utility Commissions around the country are expressing increasing interest in energy efficiency
as an energy resource. However, traditional regulation may lead to unintended disincentives for the utility
promotion of end-use efficiency because revenues are directly tied to the throughput of electricity and gas
sold. To counter this “throughput disincentive,” a number of States are considering alternative approaches
intended to align their utilities’ financial interests with the delivery of cost-effective energy efficiency
programs. “Decoupling” is a term more are hearing as a mechanism that may remove throughput
disincentives for utilities to promote energy efficiency without adversely affecting their revenues.
In its July 14, 2004, resolution supporting efficiency for gas and electric utilities, the National Association of
Regulatory Utility Commissioners (NARUC) resolved “to address regulatory incentives to address inefficient
use of gas and electricity” (NARUC, 2004). In doing so, NARUC found that regulators are confronted with
questions about what ratemaking mechanisms would be most effective in achieving commission objectives,
satisfying the needs of utilities, and providing the greatest benefit to ratepayers. Decoupling represents a
departure from common regulatory practice, and States that are considering decoupling should approach this
with appropriate care. For States considering decoupling, this paper is intended to provide an
introduction and answer some of the most frequently asked questions, and to help determine if and
how decoupling might be used.

1. What is decoupling? In the electricity and gas sectors, “decoupling” (or “revenue decoupling”) is a
generic term for a rate adjustment mechanism that separates (decouples) an electric or gas utility’s fixed
cost1 recovery from the amount of electricity or gas it sells. Under decoupling, utilities collect revenues
based on the regulatory determined revenue requirement, most often on a per customer basis. On a periodic
basis revenues are “trued-up” to the predetermined revenue requirement using an automatic rate adjustment.
The result is that the actual utility revenues should more closely track its projected revenue
requirements, and should not increase or decrease with changes in sales. Since utilities will be protected
if their sales decline because of efficiency, proponents of decoupling contend that they are more likely to
invest in this resource, or may be less likely to resist deployment of otherwise economically beneficial
efficiency.2 Decoupling is also being explored in the water utility sector, though this paper focuses on the
electricity and natural gas sectors.

2. How does decoupling work? Decoupling begins with the same rate case process as current
regulatory models use, so it is useful to review traditional ratemaking to understand how decoupling works.
How are rates are set under traditional regulation? With traditional regulation, the rates utilities can
charge are determined in a rate case, using the "cost of service” theory of regulation.3 Rates are set at a

1
 For our purposes “fixed costs” are those costs incurred to render service, which remain relatively constant
between rate cases. These typically include investment costs, including interest on debt and return on equity, and
unavoidable maintenance costs for power plants, transmission lines, gas pipelines, and other infrastructure, as well
as employee payroll. Variable costs are those which vary with the level of electric or gas output and include fuel
expenses, purchased power, and costs that vary broadly from month to month and are not included in decoupling
mechanisms. These are often addressed through fuel or other adjustment clauses under existing regulatory
practice.
2
  Decoupling advocates note that it removes a financial disincentive to energy efficiency, but may not create an
incentive. Some decoupling advocates also argue that decoupling can help remove barriers to the integration of
demand response and distributed resources.
3
  Why are utilities prices set by regulation and based on their cost of service? Electricity and natural gas are
considered to be essential services, and it is in the interest of society to ensure that the businesses that provide
these services can pay for the costs of their operations and capital. Because these services are provided by
 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            2
level sufficient to allow the utility to recover costs incurred in providing service to its customers based on the
operating experience of a typical 12 month period (referred to as a “test year”). Test year expenses include
the commission-determined or -allowed rate of return on investments. The utility’s revenue requirement is
determined by adding the total of these expenses and the allowed return on investment. The revenue
requirement is divided by the amount of sales in the test year to derive throughput based rates. In a rate case,
test-year sales and operating costs are typically adjusted to reflect “normal” weather. This can be based on a
model of future years, or it can be based on past years: test years based on forecasted experience are known
as future test years, while test years based on prior financial performance are referred as historical test years.
Regardless of the type of test year used, the resulting prices are what customers pay per unit of electricity or
gas that they use until rates are reset with next rate case.
How does traditional rate regulation create a throughput incentive? While prices are based on test
year information, after a rate case actual sales will almost always differ because the exact patterns of
customer use are complex to predict: weather, changes in the economy, demographic shifts, new end-use
technologies, additions or reductions in the number of customers, and many other factors can affect actual
sales. As a result, it is highly likely that the utility will sell more or less electricity or gas than had been
assumed for the test year during the rate case. However, fixed costs are likely to be predictable. In the
energy sector, the cost of service tends to have a large component of fixed costs associated with investments
like power plants, gas pipelines, and electric transmission lines. This makes it difficult, but not impossible,
for the utility to increase profits by cutting costs4. Revenues are much easier to increase, which means that
utilities have a strong incentive to increase revenues by increasing sales. For existing customers, sales
growth may not require a great deal of new infrastructure and in these cases, the utility’s fixed costs would
not go up with increased sales5. In these cases, increases in sales volumes translate into increased revenues
which in turn directly lead into increased profits. In fact, some observers have noted that because of the
link between profits and sales, a 1% increase in sales might lead to a 5% increase in profits (with
corresponding decreases in profits when efficiency reduces sales) (Harrington, 2007, 1994). Because the
utility makes more money and profit by selling more electricity or gas, this structure could theoretically
create a significant disincentive for utilities to encourage their customers to lower consumption through
energy efficiency.

3. How is decoupling different? Decoupling does not change the traditional rate case procedure but,
in its simplest form, adds an automatic “true-up” mechanism that adjusts rates between rate cases based upon
the over- or under-recovery of target revenues. As in the traditional rate case, a rate is set by determining the
revenue requirement and dividing it by expected sales6. Then, on a regular basis, prices are re-computed to


monopoly utilities, customers could be vulnerable to price exploitation. As a result, for over a century, prices
have been regulated by State PUCs to recover the utilities’ costs, while utilities have assumed an obligation to
provide service to the public.
4
  What about variable costs? Even though utilities’ fixed costs are high, they also see fluctuations in variable
items such as purchased power and the cost of fuels like coal or natural gas. These items are, in part, covered in
the rate set in a rate case, but unexpected costs are also covered through surcharges that are temporary in nature
and do not involve going through a whole rate case. Fuel Adjustment Clauses are an important variable cost that
is passed through directly to customers in most states. Decoupling is not applied to these variable components.
5
  For new customers, infrastructure costs may reflect regional patterns. In some regions of the country, adding
new customers may require high additional infrastructure costs: connecting a building full of new gas customers in
the urban areas of the Northeast may require a short new addition of pipe in an area with an existing distribution
system. In other areas, adding new customers means adding costly new infrastructure, such as building long
system additions to provide new gas service to rapidly-growing areas of the Southwest.
6
  In decoupling’s simplest form, prices are adjusted to maintain a constant target revenue; however, in most
applications of decoupling the target revenue is adjusted for changes in the customer base so that the revenue
target varies with the number of customers, but not on the basis of how much electricity or gas the utility sells.

 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            3
collect a target revenue based on actual sales volumes7. Decoupling mechanisms can be designed to be
adjusted on a monthly or quarterly basis, or some other regular interval.
The end result is that utilities should no
longer have an incentive to maximize                    A hypothetical example of how decoupling might
their sales because the rate of return does                                 work:
not    change    within     the     revenue
requirement. Nor is there a disincentive to         During its rate case, Utility A determines it will have a $1
promote efficiency.                                 million revenue requirement to provide electricity service 25
                                                    million kilowatt hours (kWh) of electricity in a test year. Under
Decoupling should have the effect of                the existing system, this means Utility A will charge $.04 per
stabilizing the revenue stream of a                 kWh1.
utility because its revenues are no longer
dependent on sales. If sales increase, rates        If a successful energy efficiency program helped customers
drop in the next period; if sales decrease,         reduce overall consumption in by 1.5%, the utility would sell
rates increase to compensate. Under                 375,000 fewer kWh, and its revenues would decline by
traditional rate regulation, there is little        $15,000. Under decoupling, prices would be adjusted to $.0406
oversight of earnings between rate cases,           per kWh to maintain the $1 million dollar allowed revenue
and it may be years before rates are re-            recovery.
aligned with actual revenue requirements.
                                                    If a customer’s rate goes up, their bill won’t necessarily follow,
Since decoupling adjusts actual revenues
                                                    as will be discussed later in the FAQ: the bill-reduction benefits
to align them with revenue requirements,
                                                    of consuming less significantly outweigh the reduction in those
its proponents argue that it reduces
                                                    benefits that is caused by rates being adjusted.
regulatory lag.

4. What is the relationship between decoupling and incentives for energy efficiency?
If utilities are required to promote energy efficiency programs, their revenues may be affected through a
variety of mechanisms. Commissions can address these new costs by providing program cost recovery and
shareholder incentives, as well as by addressing the throughput issue.
A great deal has been written about incentives for energy efficiency, which is a related but different
discussion. While it can remove disincentives for utilities to promote efficiency, decoupling is not
designed to create an incentive for energy efficiency. Furthermore, as discussed above, there are other
methods that remove the throughput disincentive, although revenue decoupling may best balance the removal
of utility disincentives to energy efficiency while preserving customer incentives to deploy energy efficiency.
Some decoupling proponents have argued that removing disincentives is not enough. They contend that
the cost of efficiency programs should be included as part of the cost of service. Moreover, in order to make
efficiency investments profitable when compared to other possible investments that the utility could make,
such as power plants or transmission, performance incentives for efficiency would reward utilities that invest
in successful programs by allowing them to earn an equivalent rate of return on those investments.
Conversely, some argue that incentives alone, without decoupling, are a better approach to driving
energy efficiency. They note that many utilities are doing little to promote additional sales of electricity and
the increases are customer-driven. Furthermore, some who have investigated decoupling note that in many
cases utility spending on efficiency is already effective, cost-effective and well-managed. (Connecticut
DPUC, 2006, NASUCA 2007 Resolution). In addition, large customers have argued that they may already
possess the means and incentives to enact energy efficiency measures, and that decoupling does little to
create new opportunities for efficiency in these markets (ELCON 2006).


7
  The target revenue can be the same as that used in the last rate case, or it too can be adjusted over time by
increasing or decreasing the average revenue per customer value. More information on alternatives to the Per-
Customer method is included later in the FAQ.

 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            4
Finally, some argue that utilities are not the best providers of energy efficiency. In this argument,
utilities are organizations designed to deliver kilowatt hours and therms to their customers, and are ill-suited
to champion products that “unsell” electricity or gas. Arguments have been made that taking utilities out of
the efficiency businesses and having that function played by a State, quasi-State, or private sector entity is a
preferable alternative to removing disincentives to their promoting efficiency (ELCON, 2006). In fact,
numerous examples exist of successful efficiency programs being delivered by non-utility providers.
However, some make the case that if utilities are required to examine efficiency as a resource comparable to
supply (generation) and delivery (transmission) resources, this may create a perverse tension between the
utility’s least-cost resource planning processes and the financial interest of its shareholders (Costello, 2006)
In situations where the utility is recast as a provider of energy services, rather than a strict provider of
kilowatt hours or therms, decoupling may help remove this tension (Costello 2006, NAPEE, 2006).
Some proponents of decoupling also note that even if a the utility is taken out of the efficiency business and
that function is played by a State, quasi-State, or the private sector, the problem of the effect of decreased
sales on utility revenues due to energy efficiency and the consequent decreased likelihood of the utility
receiving its authorized revenue requirement does not go away. In this argument, even if other entities are
responsible for providing energy efficiency services, the same need for decoupling still exists.
Whether decoupling will in itself result in increased efficiency is still the subject of debate. While no
major studies have been undertaken linking decoupling directly to increased efficiency activities at utilities,
anecdotally energy efficiency advocates point to strong increases in efficiency spending concurrent with
decoupling undertaken by utilities, in particular in the electricity sector, with examples such as Puget Energy
and PacifiCorp increasing activity and spending under decoupling and experiencing drop-offs in efficiency
spending when decoupling was rescinded (NRDC, 2001). However, a closer look at Consolidated Edison’s
efficiency spending while using decoupling (1993-1997) tells a different story: in this time period, efficiency
spending increased by all the regulated utilities in New York, whether they used decoupling or not.
           Decoupling is one of three major approaches for dealing with the throughput issue:
1. Full or Per-Customer Adjustment Revenue Decoupling. This is the mechanism that has been
discussed so far. It adjusts utility revenues for any deviation between expected and actual sales regardless of
the reason for the deviation. A variation of the full sales adjustment clause is the per-customer method,
which sets a per-customer revenue target. In the years following a rate case, allowed revenues are adjusted
for increases or decreases in the number of customers. In addition to Sales-Revenue Decoupling, another
variation called “Sales-Margin Decoupling” separates margin recovery from sales by setting a margin-per-
customer target. Any of these can use a forecast of revenue or use historical years to create a test year from
which to derive the revenue target.
2. Net Lost Revenue Recovery, Lost Revenue Adjustments, or Conservation and Load Management
Adjustment Clauses. This mechanism adjusts net changes in revenues only for sales deviations that can be
proven or demonstrated to have resulted from conservation and load- management programs. Revenues
continue to be susceptible to variations in sales from all other causes. While favored by some observers, this
mechanism has also been criticized as being less effective than decoupling because it does not remove the
sales incentive, can require much more sophisticated monitoring and evaluation, and could allow utilities to
recover costs for expenditures on programs that do not result in increased efficiency.
3. Straight-Fixed Variable Rate Design. This mechanism eliminates all variable distribution charges and
costs are recovered through a fixed delivery services charge or an increase in the fixed customer charge
alone. With this approach, it is assumed that a utility’s revenues would be unaffected by changes in sales
levels if all its overhead or fixed costs are recovered in the fixed portion of customers’ bills. This approach
has been criticized for having the unintended effect of reducing customers’ incentive to use less electricity or
gas by eliminating their volumetric charges and billing a fixed monthly rate, regardless of how much
customers consume.


 This research document is presented for consideration by the membership of the National Association of Regulatory Utility
Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members.
                                                            5
5. Is decoupling new? What States have implemented a decoupling mechanism?
Although only a few States have adopted it, decoupling itself is not a new idea; in fact, it has been
implemented in some parts of the country for decades. California has the most experience with decoupling,
having operated such a mechanism in the electricity sector from 1981 through 1996, and just recently
restarting the system in the State. Others that have implemented decoupling are detailed on the map below.


              Ill. 1: States That Have Considered Electricity or Gas Decoupling




            State has energy efficiency program, decoupling is not
            used (10 states)
            State has energy efficiency program, decoupling was
            proposed but not adopted (10 states)
            State has energy efficiency program, currently
            investigating decoupling (4 states & DC)
            State has energy efficiency program, decoupling has been
            approved for at least one utility (9 states)
            State has no energy efficiency program, decoupling has been    Adapted from D. Dismukes, Louisiana State University,
            approved for at least one utility (1 state)                    2007



Note that some of these States have recently adopted decoupling (like Idaho), others have been using it for
some time (e.g. Maryland), some have considered and rejected it (e.g. Connecticut and Arizona), some have
discontinued using it (e.g. Maine) and others have discontinued, and then returned to using decoupling (e.g.
California).

6. Will decoupling raise customer bills?           Because of the adjustment mechanism, some designs of
decoupling could potentially result in more frequent up-and-down changes in rates for consumers.
However, by increasing the frequency with which rates are brought into alignment with the PUC-approved
revenue requirement, the changes should be smaller, and the likelihood of a sharp hike or decline in rates
(common in traditional rate cases) may be reduced.
Decoupling could create higher bills for customers who do not participate in efficiency programs,
although proponents of decoupling argue that these reductions would be diluted across a wide enough
customer base to render any increases nearly unnoticeable. This may not occur, however, if decoupling is
applied to a small customer class, where the effect of conservation in rates may be more pronounced.
Of special concern is the impact on low-income users, who would be least able to respond to changes in bills.
Decoupling proponents note that this heightens the profile of targeted energy efficiency programs that serve
these customers, lowering their bills without impacting utility revenues.
Others with concerns about decoupling comment that unless it is designed to avoid doing so, decoupling
could create unfair transfers between customer classes. For example, if transfers between classes are
allowed, commercial and industrial customers who are ineligible to participate in residential efficiency
programs might see higher rates resulting from those programs.


 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                                       6
Will rates go up for customers who implement energy efficiency? Because they are consuming less, these
customers’ bills will go down. Rates for all customers under a decoupling mechanism may increase in the
short run when efficiency reduces sales because the utilities have to cover their costs and necessary returns
on investments. In the example above, if the utility is selling fewer kWh of electricity, but its revenue
requirement remains the same, each kWh will need to cover a greater share of the cost of service and will
need to be priced higher. However, any rate increases would be small, particularly when compared to
the benefits for customers engaging in conservation, and some analysis suggests the systemwide benefits
from increased efficiency may outweigh costs for all customers8. Moreover, if efficiency programs cut sales
without lessening fixed costs, under traditional regulation rate calculations would reflect that in the next rate
case anyway.
Will decoupling result in rampant rate instability? In the experience of some States, such as New York,
California, and Oregon, fluctuations in rates under decoupling were less than 1% for ratepayers in most
years, and never exceeded 4%. Customers may already see significantly greater rate variability through
surcharges for fuel and purchased power. Moreover, rate variability under decoupling may depend on a
number of factors, including the program design, but also including other factors, like economic and weather
variability. These examples and issues are discussed more in the section on “Does Decoupling Transfer Risk
to Customers” section, later in the FAQ.
In theory, decoupling adjusts rates to more closely maintain the underlying relationship between prices and
revenue requirements over time. This should lessen the likelihood of large-scale “rate shocks” in the
next rate case (though this may vary based on the frequency of the reconciliation.) There are other
mechanisms that can be put into place to reduce the frequency of large rate adjustments, including using a
balancing account, applying a “Rate-Adjustment Band,” or including a course-correction mechanism.
These are also discussed in more detail in the “Off-Ramps & Adjustments” section later in the FAQ.
How is decoupling different from having more frequent rate cases? Decoupling does not change the rate
base and rate of return decided in a rate case. It is also worth remembering that decoupling affects revenue
only between rate cases: at the next rate case, the base rates are reset, using the mechanisms familiar to
regulators in traditional cost of service regulation. Some have argued that a utility would not need
decoupling if it regularly entered into rate cases. Decoupling proponents have replied that it is a mechanism
used to make utilities indifferent to sales as a function of profits, and that regular rate cases remain essential
but are not the same thing. Moreover, rate cases are expensive and time consuming, and most consider it
impractical to revise base rates with the frequency proposed for adjustments under decoupling. In the
1990s, Wisconsin revised its base rates each year but discarded this approach because of the effort involved
and the less-predictable incentive structure created for utilities by the short period between rate cases.9

7. Does decoupling transfer risk from the utilities to customers? Efficiency is not the only
variable that can affect sales. For example, an unexpectedly hot summer can increase sales, or an economic
downturn can drive commercial customers out of business and reduce sales. Under traditional regulation,

8
 Rates may go up to restore the lost distribution revenue, but utility bills could also drop as cost-effective
efficiency offsets the need to purchase more expensive kilowatt-hours or therms. In this case, the utility would be
able to sell less electricity or gas with no corresponding loss of revenue, while customers would benefit by
avoiding the costs of the electricity or gas that is not needed.
9
  Some commenters have raised an objection to decoupling, making the case that it violates a regulatory
principle against single-issue ratemaking. They note that decoupling focuses on efficiency and ignores other
sources of costs increases & decreases that are considered in a traditional rate case that may counterbalance
changes in rates from efficiency. Decoupling proponents argue that with normalization mechanisms, these other
factors are taken into account and that decoupling simply raises the profile of demand-side management’s effect
on revenue. On a regulatory theory level, they assert that decoupling meets the requirements for a “tracker”, a
ratemaking instrument designed to take into account specific issues that have effects on rates.

 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            7
risk is borne by utilities (and shared with customers via rate pass-throughs) for a number of factors that can
affect sales that are beyond the utility’s control. In both cases, the utility’s fixed costs would remain the
same, and changes in revenues would not be related to changes in underlying costs for the utility to provide
service. Some argue that because decoupling constrains the utility’s revenues to “normal weather” levels and
economic trends, theoretically the utility’s business and weather risk conveyed in rates for fixed costs is
eliminated entirely. They have raised a concern that this represents a shift of risk from the utility to
customers.
One of the main reasons some Public Utility Commissions are reluctant to explore decoupling is the concern
that revenues could remain stable for utilities even if weather or business factors cause customer rates
to increase or to incur large balances in deferral accounts, illustrated by Maine’s experience in the 1990’s
(see box, this page.)
                                                                           Proponents assert that decoupling
                    Maine’s decoupling experience                          can         use        normalization
 If the impact of energy efficiency is not adequately anticipated          mechanisms to eliminate these
 during the rate case, sales will be lower than expected and rates         risks or assign them appropriately,
 will go up. But rates could also go up if sales are lower because of      and some State experiences suggest
 a mild summer or an economic downturn. This created a crisis in           that decoupling may not shift any
 Maine, which had pioneered a decoupled rate design with Central           risk to consumers.        California’s
 Maine Power in 1991 but faced a recession in the early 1990s. The         Electric       Rate        Adjustment
 recession resulted in lower electricity sales, and the decoupling         Mechanism (or ERAM, which
 adjustments kicked in to reflect pre-recession target revenues,           operated between 1981 and 1996)
 causing rates to go up when customers were least prepared to pay          adjusted the target revenue based on
 them. This sudden and sharp downturn in the Maine economy                 factors affecting the cost of service
 reduced consumption to a much greater degree than the utility’s           which were beyond the utility’s
 efficiency efforts, and decoupling became increasingly viewed as a        control, such as inflation or weather.
 mechanism that was shifting the economic impact of the recession          A 1994 analysis of California’s
 from the utility to consumers, rather than providing the intended         program found that “the record in
 energy efficiency and conservation incentive impact. By 1993,             California indicates that the risk-
 deferrals accumulated by the adjustment mechanism had reached             shifting accounted for by ERAM is
 $52 million, and the PUC and the utility agreed to end the                small or non-existent and, in any
 experiment. (Maine PUC, 2004)                                             case, ERAM has contributed far
                                                                           less to rate volatility than have
 It should be noted that while decoupling is often cited as the culprit    other adjustments to rates, such as
 here, in fact the economic downturn was the problem. Traditional          the fuel-adjustment clause.” The
 regulation would have eventually yielded rate changes through a           analysis concluded that California’s
 traditional rate case and the resulting price increases would have        decoupling created lower risks for
 reflected the same economic circumstances.                                consumers (that they could be faced
                                                                           with unexpected bill increases) and
profit risk reductions to utilities (who could be assured of fixed cost recovery, even in the face of efficiency
improvements) (Eto et al, 1994).
The authors went further, undertaking a statistical analysis to calculate the dollar value of risk from shifts in
weather and economic activity under decoupling in a hypothetical case. Based on these estimates, the
authors concluded that with the normalization procedures used in this decoupling structure, the quantitative
risk burden transferred to consumers would be one-fifth of one percent of electricity revenues from each of
those customers – a $2 risk-shifting burden on a $1200 annual bill. (Eto et al, 1994)
Consolidated Edison in New York had a similar mechanism in place from 1993 to 1997. The rate variability
under this system suggests that rate impacts were minimal here as well. In 1993, a shortfall with just under
3% effect on rates was collected from customers, and rates went up. For the next four years, over-collections
occurred, and rates went down just under 1% per year. (NRDC, 2001)

 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            8
Under some decoupling mechanisms (such as some of those implemented in the Pacific Northwest) the
revenue target can be adjusted to accommodate unexpected weather patterns. Northwest Natural Gas
in Oregon, for example, subtracts an estimated sales impact for weather from its periodic adjustment. A
more complex, but comprehensive, approach is called “statistical recoupling,” in which weather, fuel costs,
economic changes, and the number of customers is modeled, and that model is used to determine the revenue
target. (Eric Hirst, 1993)
Some have raised a concern about statistical recoupling and other economic and weather normalization
methods, commenting that adding these systems makes decoupling so complicated that its
administrative and accounting burdens can outweigh its benefits, or that it can be manipulated to
allow “over-earning” by utilities. Some proponents of decoupling respond that weather and economic risk
is already shared with consumers through rates, and that the traditional rate case structure simply delays
accounting for these costs (or revenues) until the next rate case. Moreover, weather normalization
computations of some type are universally included in the determination of the revenue requirement in each
rate case, with about half of the States allowing normalization adjustments between rate cases.

8. Will decoupling discourage utility companies from cutting their costs? No. Concerns
have been raised that to the extent that utilities become isolated from possible changes in revenues, they have
little motivation to lower their costs in order to meet their revenue requirement. However, because
decoupling affects only revenues, the utility remains at risk for any changes in costs. Decoupling
proponents argue that the rate case mechanism underlying decoupling continues to ensure that utilities strive
to control fixed costs that cannot easily be reduced to the greatest degree possible. They note that
performance indicators can also be included to identify when cost reductions have arisen from a decreased
level of service rather than from gains in efficiency.
One solution pioneered by New Jersey in its Conservation Incentive Program allows gas utilities to adjust
their rates to account for changes in consumption resulting from efficiency efforts, but the adjustment is
capped at the amount of verifiable supply cost reductions achieved by the utility. (Fox et al, 2007)

9. Can a utility increase its profitability with decoupling? Yes. With a per-customer form of
decoupling, utilities receive their revenue from customers that cover the fixed costs of service, and that cost
of service includes a rate of return that contributes to profits. In other words, instead of making more money
by selling more kilowatt hours or therms, utilities would make more money when they increase their
customer base, regardless of whether there is a corresponding increase in sales. Alternatively, if the utility
can find a way to improve its efficiency and thereby lower its cost of service without decreasing its
number of customers, it has an opportunity to improve its bottom line. Under decoupling, the primary
driver for profitability growth is the addition of new customers, especially in areas where the addition of new
customers does not carry high infrastructure addition costs. In these cases, the customers who would bring
the greatest potential profitability to a utility are those who are the most energy efficient, since they can be
added with the lowest incremental addition to the utility’s cost of service10.
As noted before, decoupling can reduce risk for the utility by ensuring that its revenues and return on
investment remain stable. A lower risk-profile should make the cost of capital lower for the utility11.
For investors, this can be realized through an increase in the utility’s debt/equity ratio, a decrease in the
return on equity, improved debt ratings and credit requirements.



10
  Again, this may reflect differences between regions and sectors: where unexpectedly adding new customers
brings significant new operating costs not anticipated in the rate case, the outcome may be different and, as would
occur in traditional ratemaking, could trigger a rate case.
11
     Illustrating this, one utility has proposed a lower target return as part of its decoupling proposals in MD and DC.

 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            9
10. Is decoupling different for gas than it is for electricity?                Decoupling is fundamentally the
same for both gas and electric utilities. They both share similar cost structures which are dominated by high
fixed costs. However, the two industries are facing different underlying trends in customer revenues. While
the gas industry generally faces declining average revenues per customer over time, the electric industry is
experiencing increasing average revenues per customer. As a result, gas utilities tend to face revenue and
profit erosion between rate cases, while electric utilities garner increasing revenue and profits between rate
cases. Decoupling has the effect of eliminating most of these effects. As a result, gas utilities have tended to
be more open to implementing decoupling than have electric utilities. However, a small but growing number
of electric utilities have either implemented, requested or are investigating decoupling. Some have suggested
that this could be partly in response to longer-term expectation about capital expenditures and environmental
costs. Energy efficiency may be a cost-effective way to avoid potential future risks such as carbon
regulation. In addition, recent policy initiatives at both the federal and State level have embraced energy
efficiency as a high priority resource12. If energy efficiency is deployed more widely in the future, electric
utilities may become more interested in decoupling.

                                 What off-ramps and adjustments are possible?
Decoupling is a substantial departure from traditional rate-making, and may be new to States and utilities.
Therefore it makes sense to approach implementation with caution, considering corrective mechanisms to
ensure that the change in structure has the intended effects and avoids harmful unintended consequences.
Some of the mechanisms that have been considered are:
Balancing Accounts: Depending on the frequency of adjustments, a separate account can be established and
used to track and accumulate over- or under-collections, in order to defer the adjustment and “smooth out”
unusual spikes in rates. Typically this kind of account is used when adjustments are scheduled to occur less
frequently.
Rate banding: As discussed above, this triggers the periodic adjustment to rates when the changes in
revenue would result in a change within a certain percentage. If the rate band were set to 10% over or under
the target rate, only changes less than 10% would trigger the adjustment. Outside the band, a new rate case
would be triggered.
Revenue banding / shared earnings: In order to prevent unintended windfalls or shortfalls by the utility,
earnings greater or less than certain limits can be shared with customers. For example, if an earnings band is
set to 5% of return on equity compared to the allowed return found in the most recent rate case, earnings or
shortfalls greater than 5% would be shared with consumers on a proportional basis though rates. This can
also be computed on the basis of revenue changes, which avoids the complication (and potential litigation) of
computing returns on equity.
Course corrections for single events, changes in industrial customers or activity: The addition of a new
customer among large users, such as an industrial customer, or large change in the activity of a customer--a
factory adding a new shift, for example--can have a disproportionate effect on rates for other customers in
that class. In these cases, language allowing for adjustments that take special circumstances into account can
help avoid unexpected rate shifts.


11. Would decoupling work the same for regulated and deregulated States?                          Broadly
speaking, utilities in deregulated markets appear to be more vulnerable to revenue losses incurred by
decreased sales from efficiency than utilities in vertically-integrated markets. In the 2006 report on the
National Action Plan For Energy Efficiency, the authors note that “once divested of a generation plant, the

12
  For more on energy efficiency as a high priority resource, see the National Council on Electricity Policy’s study
for DOE’s Section 139 Report To Congress (2006) and the National Action Plan on Energy Efficiency, (2006).

 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            10
distribution utility is a smaller company (in terms of total rate base and capitalization), and fluctuations in
throughput and earnings have a relatively larger impact on return.” (NAPEE, 2006)
In States where distribution utilities purchase most or all of their commodities from a wholesale market,
decoupling would be integrated into the largely-fixed cost structure of the distribution utilities. In States with
vertically integrated utilities, decoupling can also be applied, but care must be taken in the rate case context
to accurately separate fixed costs from variable costs, applying the decoupling adjustments only to the fixed
costs. In all other respects, decoupling is applied in the same manner in both types of situations.

12. Where can I find out more?           This FAQ was authored by Miles Keogh of NARUC’s Grants &
Research staff with funding from the U.S. Environmental Protection Agency. It was developed through
research, interviews, and input from a number of parties, including the staffs of the New Jersey Board of
Public Utilities, Massachusetts Department of Public Utilities, Arizona Corporation Commission, US
Environmental Protection Agency, North Carolina Attorney General’s Office, and Public Service
Commission of the District of Columbia. Oversight was provided by Commissioner Rick Morgan of the
District of Columbia PSC, and technical assistance came from Wayne Shirley of the Regulatory Assistance
Project. More resources on decoupling are included below.

RESOURCES
1.	 NARUC Resolution on Gas & Electric Energy Efficiency, July 2004.
     http://www.naruc.org/associations/1773/files/gaselectriceff0704.pdf
2.	 The US Department of Energy EPAct Section 139 Report to Congress, Appendix A, “A Study by the National
     Council on Electricity Policy on State And Regional Policies That Promote Electric & Gas Utility Programs To
     Reduce Energy Consumption, March 2007 http://www.ncouncil.org/pdfs/139_Rpt.pdf
3.	 The National Action Plan on Energy Efficiency, US EPA / US DOE, Chapter 2, July 2006
     http://www.epa.gov/cleanrgy/pdf/napee/napee_chap2.pdf
4.	 U.S. Environmental Protection Agency (US EPA) “Clean Energy-Environment Guide to Action: Policies, Best
     Practices, and Action Steps for States”, (Section 6.2) June 2006.
     http://www.epa.gov/cleanenergy/pdf/gta/guide_action_chap6_s2.pdf
5.	 Costello, K., “Revenue Decoupling for Natural Gas Utilities”, National Regulatory Research Institute, April 2006.
     http://www.nrri.ohio-state.edu/dspace/handle/2068/995
6.	 Jeanne Fox, Fred Butler, Nusha Wyner, and Jerome May: “Share The Gain, Not The Pain: Another Side To
     Decoupling”. Public Utilities Fortnightly, August 2007.
7.	 Cheryl Harrington Et Al, “Regulatory Reform: Removing the Disincentives”, Regulatory Assistance Project, June
     1994. http://www.raponline.org/Pubs/General/disincentives6-94.pdf
8.	 Dr. David Dismukes, PhD, Louisiana State University, presentation:, “Regulatory Issues for Consumer Advocates
     in Rate Design ,Incentives & Energy Efficiency”, NASUCA Mid-Year Meeting, June 11, 2007
     http://www.enrg.lsu.edu/presentations/NASUCA_DISMUKES_3.ppt
9.	 The American Gas Association & the Natural Resources Defense Council (NRDC) joint statement to the National
     Association of Regulatory Utility Commissioners, July 2004. http://www.ase.org/imgs/lib/e-
     FFICIENCY/joint_AGA_NRDC_NARUC_statement.pdf
10.	 Cheryl Harrington et. al, “Energy Efficiency Policy Toolkit”, The Regulatory Assistance Project, January 2007,
     http://www.raponline.org/Pubs/Efficiency%5FPolicy%5FToolkit%5F1%5F04%5F07%2Epdf
11.	 Eric Hirst, “Statistical Recoupling:. A New Way To Break The Link. Between Electric Utility. Sales & Revenues”
     Oak Ridge National Lab, September 1993. http://www.osti.gov/energycitations/servlets/purl/10191622-
     8J4QlR/native/10191622.PDF
12.	 J. Eto, S. Stoft, T. Belden, “The Theory and Practice of Decoupling”, Lawrence Berkeley National Laboratory,
     1994. http://eetd.lbl.gov/EA/EMP/reports/34555.html
13.	 Carter, Sheryl, NRDC “Breaking The Consumption Habit: Ratemaking for Efficient Resource Decisions” in The
     Electricity Journal, December 2001. http://www.nrdc.org/air/energy/abreaking.asp
14.	 David Moskovitz. “Profits & Progress Through Least-Cost Planning”, November 1989.
     http://www.raponline.org/showpdf.asp?PDF_URL=%22Pubs/General/Pandplcp.pdf%22
15.	 MADRI, “Revenue Stability Model Rate Rider”, the Mid-Atlantic Distributed Resources Initiative.
     http://www.energetics.com/madri/pdfs/Model_Revenue_Stability_RateRider_2006-05-16.pdf


 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            11
16.	 New York Public Service Commission Docket 04-E-0572 – Proceeding on Motion of the Commission as to the
     Rates, Charges, Rules and Regulations of Consolidated Edison Company of New York, Inc.
     http://www3.dps.state.ny.us/pscweb/WebFileRoom.nsf/Web/BFCF5488B5C3620A85256FCD005A5F0F/$File/04e
     0572.ord.03.24.05.pdf?OpenElement
17.	 ELCON, “Revenue Decoupling - A Policy Brief of the Electricity Consumers Resource Council,” January 2007,
     Washington DC. http://www.elcon.org/Documents/Publications/3-1RevenueDecoupling.PDF
18.	 Connecticut Department of Public Utility Control, Docket No. 05-09-09, Investigation Into Decoupling Energy
     Distribution Company Earnings From Sales, January 18 2006.
19.	 Simon ffitch, Washington State Attorney General’s Office, “Decoupling: Should Ratepayers Be Worried?”
     presentation to NARUC Decoupling Workshop, August 2006.
     http://www.masstech.org/renewableenergy/public_policy/DG/resources/2006-
     08_NARUC_Ffitch_Decoupling_concerns.pdf
20.	 NASUCA “Energy Conservation And Decoupling Resolution”, the National Association of State Utility Consumer
     Advocates, July 2007 www.nasuca.org/Resolutions/Decoupling-2007-01.doc
21.	 Maine Public Utilities Commission Report on Utility Incentives Mechanisms for the Promotion of Energy
     Efficiency and System Reliability, February 2004
     http://www.mtpc.org/renewableenergy/public_policy/DG/resources/2004-02-01_ME-PUC_Eff-RelReport.pdf
22.	 NARUC, Resource CD On Aligning Utility Incentives With Demand-Side Resources, Washington DC 2006.




 This research document is presented for consideration by the membership of the National Association of Regulatory Utility 

Commissioners (NARUC). This document does not necessarily represent any NARUC policy nor those of any of its members. 

                                                            12

				
DOCUMENT INFO
Shared By:
Categories:
Tags: electric
Stats:
views:44
posted:9/21/2012
language:English
pages:12
Description: In its July 14, 2004, resolution supporting efficiency for gas and electric utilities, the National Association of Regulatory Utility Commissioners (NARUC) resolved “to address regulatory incentives to address inefficient use of gas and electricity” (NARUC, 2004). In doing so, NARUC found that regulators are confronted with questions about what ratemaking mechanisms would be most effective in achieving commission objectives, satisfying the needs of utilities, and providing the greatest benefit to ratepayers. Decoupling represents a departure from common regulatory practice, and States that are considering decoupling should approach this with appropriate care. For States considering decoupling, this paper is intended to provide an introduction and answer some of the most frequently asked questions, and to help determine if and how decoupling might be used.decoupling? How does decoupling work?